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Government Spending and Taxation. 1. 6. 1. 4. 1. 5. Government Expenditures. Growth of Government. During the first 125 years of U.S. history, federal expenditures per person were small and they grew at a relatively slow rate. (See following slide)

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slide3

Growth of Government

  • During the first 125 years of U.S. history, federal expenditures per person were small and they grew at a relatively slow rate.(See following slide)
  • In contrast, federal spending soared throughout most of the 20th century. In 2008, real federal spending per person was roughly 70 times the level of 1916.
  • During the 1990s per capita real federal spending was relatively constant. In fact, it declined slightly during the decade.
  • Since 2000, per capita real federal spending has once again been increasing rapidly.
slide4

Real Federal Expenditures

Per Capita:1792-2008

Real federal spending per person(in 2000 U.S. dollars)

$ 8,000

$ 7,000

$ 6,000

$ 5,000

$ 4,000

$ 3,000

$ 2,000

$ 1,000

1800

1850

1900

1950

2000

  • Real federal spending per person (measured in 2000 dollars) grew slowly during the first 125 years of U.S. history, but it soared throughout most of the 20th century.
slide5

Changing Nature of Government

  • During the last four decades, federal spending has shifted away from national defense and toward spending on income transfers and health care.
  • In 2008, national defense accounted for only 21.0% of the federal budget, down from 52.2% in 1960.
  • In contrast, spending on income transfers and health care rose from 21.5% of the federal budget in 1960 to 57.7% in 2008.
slide6

58 %

57 %

52 %

44 %

44 %

42 %

30 %

24 %

23 %

22 %

21 %

17 %

Health & income transfer expenditures(share of federal spending)

Defense expenditures(share of federal spending)

Health care

Income transfers

The Changing Composition

of Federal Spending

1960

1970

1980

1990

2000

2008

1960

1970

1980

1990

2000

2008

  • During the last four decades, federal spending has shifted sharply away from national defense and toward income transfers and health care.
slide7
Taxes and the

Finance of Government

slide8

Taxes and Other Revenue Sources

  • Governments are financed by taxes, user charges, and borrowing.
    • Borrowing implies higher future taxes.
  • The power to tax is a distinguishing characteristic of government.
  • The major sources of federal revenue are the personal income tax (accounted for 45.4% of federal revenue in 2008)and the payroll tax (accounted for 35.7% of the total in 2008).
  • Major revenue sources at the state and local level are sales and excise taxes, personal income taxes, user charges, and grants from the federal government.
slide9

User charges

19.7%

Property

13.1 %

Personal income45.4%

Payroll35.7%

Interestearnings2.6%

Personalincome9.8%

Sales &

excise

15.1%

Corporateincome

1.9%

Other3.0%

Customs

duties 1.1%

Excise2.7%

Other

21.3%

Corporateincome 12.1%

From Federalgovernment 16.5%

Federal government revenue2008 -- $ 2,524 billion

State & local government revenue2006 -- $ 2,737 billion

Sources of Government Revenue

slide10

Taxes and the Cost of Government

  • A dollar of taxation costs the economy more than a dollar because:
    • It is costly to administer, enforce, and comply with tax legislation.
    • Taxes distort incentives and eliminate productive exchanges (and cause people to undertake some counterproductive activities).
    • Economists refer to this as the “dead weight loss” of taxation.
slide11

How Has the Structure of the

Personal Income Tax Changed?

  • The share of the income tax paid by high-income taxpayers has risen during the past 40 years – especially since 1980. (This is demonstrated graphically on the next slide.)
  • Why has the share paid by those with high-incomes risen?
    • The decline in marginal tax rates has created greater “incentive effects” for high-income tax payers to earn taxable income.
    • The standard deduction and personal exemption have increased substantially over the past two decades.
slide12

Share of Federal Income Taxes

Paid By Various Income Groups

Share of total federalpersonal income tax paid

Income group

1963

1980

1990

2006

Top 1%

18.3 %

19.1 %

25.1 %

39.9 %

Top 5%

35.6 %

36.8 %

43.6 %

60.1 %

47.0 %

49.3 %

55.4 %

70.8%

Top 10%

Top 25%

68.8 %

73.0 %

77.0 %

86.3%

Top 50%

89.6 %

93.0 %

94.2 %

97.0%

Bottom 50%

10.4 %

7.1 %

5.8 %

3.0%

  • Upper-income Americans pay the bulk of the federal income tax and the share they pay has risen during the last 4 decades.
slide13

25.5 %

17.4 %

14.2 %

9.9 %

4.3 %

Total Federal Taxes

As a Share of Income, 2005

Federal taxes as a share of income (%)

Lowest

Second

Third

Fourth

Highest

–––– Family income groups –––– (quintiles)

  • Here we show the payment of federal taxes as a share of income for each income quintile.
  • Note the overall federal tax structure is highly progressive.
slide14

Does the Growth of Income

Benefit the Federal Government?

  • Federal personal income tax brackets are indexed for inflation, but no adjustments are made for increases in real income.
  • Under the current progressive tax structure, the growth of real income will increase federal revenues as a share of total income if no offsetting action is taken.
slide15
Size of Government:

U.S. versus Other Countries

slide16

Size of Government:

U.S. Versus Other Countries

  • The size of government in the U.S. is smaller than that of Japan and the major Western European countries, but larger than for a number of high-growth Asian economies.

(See the following slide.)

slide17

Size of Government:

An International Comparison

Japan

36.1%

Government expenditures as a share of GDP, 2007

Sweden

52.8 %

France

52.4%

Denmark

51.2%

Austria

48.4%

Belgium

48.2%

Italy

48.2%

Portugal

45.9%

Netherlands

45.3%

United Kingdom

44.4%

Germany

43.8%

Greece

43.7%

Norway

40.6%

Canada

39.6%

Spain

38.8%

United States

37.2%

New Zealand

36.7%

Ireland

35.5%

Australia

34.4%

South Korea

22.6 %

Thailand

20.9%

Hong Kong

17.4%

Singapore

15.2%

slide18
The Size of Government

and Economic Growth

slide19

The Size of Government

and Economic Growth

  • The core functions of government such as a sound legal system, access to money of stable value, and provision of public goods that are difficult to provide through markets will promote economic growth and help citizens achieve high income levels.
  • But when government expands beyond these core functions and into areas for which it is ill-suited, it will retard economic growth.
slide20

Growth rate of the economy

B

6%

3%

A

Size of government(percent of GDP)

Size of Government – Growth Curve

  • If governments undertake activities in the order of their productivity, the growth of government will initially promote economic growth (move from A to B).
  • At some point, however, continued expansion of government will retard growth (moves beyond B).
slide21

Data are for the 23 long-standing

member countries of the OECD

Govt Spending and Economic Growth

  • The relationship between the size of government at the beginning of the decade and the growth rate of real GDP for each decade during the 1960-1999 period is shown below.
  • An increase in government spending of 10% (as a share of GDP) reduces annual growth by about 1%.

Growth rate(respective decade)

10 %

8 %

6 %

4 %

2 %

0 %

10 %

20 %

30 %

40 %

50 %

60 %

Total government expenditures (start of respective decade)

Source:OECD, OECD Economic Outlook (various issues)and The World Bank, World Development Indicators, 2001, CD-ROM.

slide22

The Future of Government Spending

in the United States

  • A major share of U.S. government spending (e.g. Social Security & Medicare) is directed towards the elderly.
  • As the baby-boom generation begins to retire around 2010, federal expenditures are almost certain to grow as a share of the economy.
  • In turn, the higher level of government spending is likely to slow the growth rate of the economy.
slide23

Questions for Thought:

1. A century ago, federal taxes and spending per person were substantially lower than today. How would the U.S. economy be affected if the federal government was, for example, one-third its current size? What programs would you favor cutting?

2. Because the structure of the personal income tax is progressive, more income is taxed at higher rates as income grows. Therefore, economic growth automatically results in higher taxes. Do you think this is an attractive feature of the current tax system?

slide24

Questions for Thought:

3. The marginal tax rates imposed on those with high incomes are now substantially lower than in 1980. Would you like to see higher tax rates imposed on high income Americans? Do you think higher rates would increase the tax revenues collected from high-income Americans?

4. “Real federal spending per person grew slowly under the Reagan Administration during the 1980s, but it increased rapidly under the Clinton administration in the 1990s.” -- Is this statement true?

slide25

Questions for Thought:

  • 5. Are the following statements true or false?
    • a. During the first 125 years of U.S. history, federal expenditures per person were small and they grew at a relatively slow rate.
    • b. In 2006, real federal spending per person was about 70 times its level of 1916.